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Contracts enforceable, unless law contravenes

Last month, as I described two weeks ago, the New Mexico Supreme Court reversed a $3.5 million jury verdict in a business dispute between Farmers Insurance and one of its agents. A Santa Fe jury heard the evidence and found that the Farmers defendants engaged in “intentional and malicious behavior” when they terminated the agency agreement. “In effect,” one judge of the Court of Appeals wrote, “the jury found that the individuals who effected the firing acted like corporate hyenas and jackals cannibalizing their own.”

None of that mattered, according to our Supreme Court when it reviewed the case, because the actions of the Farmers defendants were permitted by the agency agreement. In overturning the jury verdict, the court relied on New Mexico’s “public policy that favors the freedom to contract.”

The phrase “freedom to contract” might give a misleading impression. It might seem to promise a libertarian paradise or (depending on your politics) invoke a nightmare of Gilded Age rapacity. But upon examination, the phrase means surprisingly little.

In the first place, many documents that are labeled contracts don’t really qualify, legally speaking. Contracts entered under duress, or as a result of trickery, or when one signatory is a child or mentally unfit, or which don’t involve the exchange of value, might look like contracts, but they’re not enforceable. Freedom of contract does not extend to such documents.

Then, too, contracts are unenforceable when they require the commission of a crime. A smuggler who bribes a customs official has entered a type of contract, but no court would enforce it. Since 1865, no American court has upheld a contract to buy or sell a human being. Contracts for the sale of illegal drugs are enforceable only by extralegal violence, as our crime statistics remind us. Freedom of contract is strictly limited by the criminal law.

But even when a contract is freely entered by competent adults, observes all the formalities, and doesn’t require anyone to commit a felony, it is not necessarily enforceable. In 2015, our Supreme Court examined a standard form oil and gas contract utilized by Artesia’s Yates Petroleum (before it was acquired by EOG Resources). The contract recognized Yates’ responsibility to make payments to owners of fractional interests in its wells. But if a person claiming an ownership interest was unable to prove title, the contract authorized Yates to “withhold payments without payment of interest until the claim is settled.”

The difficulty is that New Mexico’s oil and gas law specifically provides that when an operator suspends payment, owners are “entitled to interest on the suspended funds.” The contract said no interest. The statute said yes interest. Which one controlled?

The very fact that the question was debated in New Mexico’s courts revealed a paradox. In effect, Yates was demanding that the state’s legal institutions enforce the company’s selective refusal to abide by the state’s laws. Yates wanted the protection of the legal system while exempting itself from an obligation imposed by that same legal system.

Our Supreme Court refused to let Yates have it both ways. Quoting a 1967 case, the court held that contracts are to be enforced as written “unless they clearly contravene some law or rule of public morals.” Leaving aside the question of public morals, there’s no room to doubt that the contract’s no-interest provision contravened a law. And that law expressed “a strong public policy in favor of establishing the rights of interest owners,” which took precedence over the conflicting public policy of freedom of contract.

But how does any court decide which of two competing public policies wins? The Supreme Court’s recent decisions don’t really explain, but I think the two opinions, read together, provide a rough map through the wilderness. The key point about the Farmers case is that it involved tort law, the body of law developed to redress injuries (including financial injuries) resulting from wrongful acts. The court was saying that tort law shouldn’t be used to resolve contract disputes. The hidden motives of the parties to a contract don’t matter. Even hyenas and jackals can enter valid contracts.

The law of contracts is a staid and unchanging corner of the legal universe, particularly in contrast to the creative exuberance that characterizes tort law. But even so, freedom of contract really only means that a contract is presumed valid until challenged. The Supreme Court’s approach directs attention away from the behavior of the people involved and concentrates it instead on the document to which they affixed their signatures, or pawprints. The court’s approach has the potential to promote certainty in business dealings while streamlining courtroom procedures.

Joel Jacobsen is an author who recently retired from a 29-year legal career. If there are topics you would like to see covered in future columns, please write him at legal.column.tips@gmail.com

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